Lecture notes: Economics of Development Introduction

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Classical theory of how development is attained

It is important to note that the first steps in establishing development economics as a branch of economic science was taken by scholars in the colonizing countries after the second world war and, thus, reflect the scholarly thinking in Europe and the US during 1950s and 60s. The dominating perspective was the linear-stages approach to development according to which all countries have to pass the same stages as the rich countries in Europe. These were made explicit in Rostow’s stages-of-growth model, where all societies starts as traditional agrarian economies that find a development strategy for a “takeoff” into self-sustaining growth.

In these theories increased domestic saving in combination with transfers of capital from the rich countries either privately or as foreign aid to accelerate investments was considered as an important condition for “takeoff” and regular growth. Thus, today many governments in developing countries base their development policies on an aggregate growth model inspired by the Harrod-Domar growth model.

/Math I here/

The logic behind using this model is that capital formation is the main obstacle to development. Labor is excluded as this factor has been considered as abundant in developing countries. It is a difference with regard to innovation and technological change which is a scarce factor in most poor countries in Africa. This factor can be incorporated into the Harrod-Domar model as a reduction in k over time. That is, as time passes, less savings and investments are needed to produce a given income.

/Math II here/

The weakness of this way of dealing with technological change is that innovation and technological change is exogenous, i.e. we are lacking a theory of innovation, to which we will return later in this course.

When using the Harrod-Domar model, some governments apply the two-gap model comparing savings gap and foreign- exchange gap to determine which is the binding gap.

Let us assume that it turns out that the savings gap dominates, which means that the foreign exchange gap is binding for capital formation. This could be a situation where the national elite uses foreign exchange, including foreign-aid, for luxury consumption abroad. As the government wish to increase the per capita incomes by increasing the growth rate, it is reasonable that it tries to encourage the elite to reallocate their incomes from consumption to investments. Alternatively, they try to increase foreign exchange by means of foreign aid and foreign direct investments. You can read more about the two-gap model on pp 702 – 703

Implicit in the linear stages approach to development , where all countries pass the same stages of development, is the idea that regular growth after “takeoff” is synonymous to industrialization and the development of a modern sector replacing traditional agriculture. However, targets for the growth of the modern sector should be judged in view of the amount of surplus labor in agriculture, which was considered as overpopulated with a marginal productivity of labor equal to zero. Thus, it was believed that labor could be withdrawn from traditional agriculture without any loss of output. At the same time, marginal productivity in the modern economy was larger than zero implying that wages were higher than in agriculture. As people were assumed to move from regions with lower wages to regions with higher wages, rural-urban migration was expected to grow fuelled by a modern sector characterized by full employment.

Development strategies in this situation was analyzed within the context of Lewis two-sector model that dominated the field of development economics during 1960s and the beginning of 1970s. Lewis assumed that the capitalists operating the modern sector reinvest all their profits. If we also assume that the workers in the sector use all their income for consumption, then this model takes for given that investments are equal to savings which means that it predictions made by this model can easily be coordinated with predictions made by the Harrod-Domar model of aggregate growth.

/presentation of the model 116 – 120/

Self-sustaining growth continues until all surplus labor has been transferred to the modern sector. This is Lewis turning point, where the slope of the labor supply curve becomes positive and further labor cannot be removed without costs in terms of reduction in the food produced in subsistence farming.

One weakness of this model is that it does not take into consideration the possibility that the capitalists invest in laborsaving capital equipment.

/figure 3.2 p 119/

One implication is that the wage-share of total value produced in the modern sector declines (and the capital share increases) and economic growth does not create any new jobs. This may be called “antidevelopment” economic growth.

When seen in view of the contemporary discussions about development strategies, one difficulty with Lewis’s model is that it neglects the importance of agriculture, which is reduced to a secondary sector. With the new understanding of development emphasizing reduction of poverty and inequality, development of agriculture comes into the fore as most of the poor people are living in rural areas.

These two linear stages approaches to development is based on the idea that all countries in principle are alike in the sense that they pass the same development stages. This is a completely different paradigm for development as compared with the Neocolonial Dependence Model that become popular among development economists from the 1980s. According to this model developing countries are considered as belonging to the periphery and the developed countries constitute the center connected to the periphery (developing countries) through power relationships. Thus, the development of the developing countries is not the same as for the developed countries as, according to these relationships, their development complies with dependent capitalism, where the economy of the countries in the periphery is conditioned by the development and expansion of the countries in the center.

Unlike the linear stages approaches that stresses the importance of internal constraints to development such as insufficient savings and investments, the Neocolonial Dependence Model defines the development strategies in relation to external constraints and the need of restructuring the world capitalistic system. This agrees with figure 2.11, where the main explanation of differences in development between poor and rich countries is institutional characteristics associated with the type of colonial regime.

When looking at possible development strategies, it is also important to note changes in the international system from anarchy and conflicts between national states to increased collaboration and the establishment of international organizations. Thus, the Neocolonial Dependence Model recognize an elite ruling class in the developing countries, which is rewarded by and serve international organizations such as the World Bank, IMF and various organizations of the UN. They share the ideology and interest of the ruling elite in the center.

For example, there are rules in the international system defined by the governments in the developed countries, saying that the foremanship of the World Bank always is allocated to an American (the US) and the foremanship of the IMF is always allocated to an European. Being a collaboration between national states in Europe, the EU is another international organization. Through its Structural Funds, and by using tariffs the EU protects agriculture in Europe from trade in agricultural products, which is very harmful for the African farmers.

From this perspective, an efficient development strategy, could be one that changes the rules for allocating foremanships in international organization, transferring power of these organizations to developing countries and to form alliances with those forces in Europe that are working for changes in the European agricultural policy. Furthermore, it was mentioned before that international trade has not been a bridge for transferring technology from the rich countries to the developing countries, and we explained that by the ability of developing countries to absorb and adapt the new technology. However, now we are in a position to discover a second factor of importance. It is referred to neoclassical economics that consider knowledge (technology is knowledge about how to produce services and commodities) as a public good free for use. However, in practice a lot of technologies that could be useful for developing countries are owned and controlled through patents by companies with domicile in the developed countries. Another example of a development strategy in the spirit of the Neocolonial Dependence Model could be to make efforts to change the international patent laws.

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